Kestrel Group Ltd (KG) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, welcome to the Maiden Holdings Limited fourth-quarter 2015 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call, Mr. Noah Fields. You may begin, sir.

Good morning and thank you for joining us today for Maiden's fourth-quarter and year-end 2015 earnings conference call. Presenting on the call today we have Art Raschbaum, Maiden's Chief Executive Officer along with Karen Schmitt, our Chief Financial Officer. Also in attendance today is Pat Haverson, President of Maiden Reinsurance Limited.

Before we begin, I would like to note that the information presented here today contains projections or other forward-looking statements regarding future events or the future financial performance of the Company. These statements are based on current expectations and future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially from these expectations.

We refer you to the documents the Company files from time to time with the Securities and Exchange Commission, specifically the Company's Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q. Some of our discussions about the Company's performance today will include reference to both non-GAAP financial measures, and information that reconciles those measures to GAAP, as well certain operating metrics that may be found in our filings with the SEC and in our news release located on Maiden's Investor Relations website.

Please also note that unless otherwise stated, all references to common share data in today's discussion are on a diluted share basis and comparative comments will refer to Maiden's result in the fourth quarter of 2015 relative to the corresponding period in 2014. Finally, certain reclassifications have been made for 2014 to conform to 2015 presentation and have no impact on net income and total equity previously reported.

I will now turn the call over to Art.

Good morning and welcome to our fourth-quarter 2015 earnings call. On this morning's call I will be providing an overview of the full year while our Chief Financial Officer, Karen Schmitt, will focus on the results of the fourth quarter.

For the full year, Maiden continued to enjoy solid growth, profitable underwriting results, enhanced-expense efficiencies and double-digit operating returns on equity. Importantly we continued to benefit from our strategic AmTrust relationship while expanding active clients in the United States, implementing our Solvency II triggered Capital Solutions business in Europe and positioning our unique European international insurance services business for expansion. We're confident that we've effectively laid the groundwork for growth in 2016 and beyond.

From a capital management perspective we took the opportunity to access the capital markets in the fourth quarter of 2015. The 7 1/8 coupon preferred-share issuance raised nearly $160 million and it provides us with a level of enhanced capital flexibility with relatively modest incremental cost, consistent with our commitment to respond to capital needs in the most shareholder-friendly manner possible. Also consistent with that objective, to further enhance capital flexibility, we entered into a strategic quota share which has been renewed for 2016.

Maiden generated an operating return on common equity of 12% for the year, compared to 13.6% in 2014. Book value at year-end 2015 was $11.77 per share, down from $12.69 per share at the end of 2014, and it reflects the impact of unrealized losses in our investment portfolio, as interest rates rose in the latter part of the year and corporate spreads widened. Our basic diluted operating earnings per common share were $1.39 versus $1.53, largely reflecting the impact of commercial auto adverse development in our US-diversified segment throughout the year.

While adverse development moderated in the fourth quarter, we also increased our book-to-loss ratios and will continue to do so across our underwriting portfolio in 2016, in view of the competitive environment and growing loss cost volatility. Notwithstanding that point, we do expect our overall combined ratio in this segment to improve.

Maiden continued to enjoy premium growth in 2015, but the pace moderated. Influenced by a combination of revenue challenges in our diversified segment and a reduced growth rate for the AmTrust segment as the impact of the Tower acquisition moderated throughout the year. As Karen will explain, we also completed a one-time commutation of certain elements of the business ceded under the AmTrust contract in the fourth quarter, which also influenced our growth rate for the year.

Overall for 2015 gross premiums written totaled $2.7 billion, an increase of 6% compared to last year. Gross premiums written in the diversified-reinsurance segment totaled $777 million in 2015, a decrease of 13.5% from the prior year. Excluding the effect of fronted business discontinued in 2014, gross-written premiums declined by 9%.

As discussed in prior quarters, this year the diversified-segment premiums also declined in 2015 as a result of the loss of a large US client in the first quarter of the year. However, absent these impacts and specific to the US book, gross-written premiums would have been up 9.1% for the year versus down 9.7%. Premium volumes were also impacted in the US by underwriting actions taken to restore profitability. Maintaining underwriting discipline is core to our success at Maiden, and as we have said many times in the past we will not sacrifice profitability for growth.

We have previously stated that we view each client relationship as an opportunity to organically build our portfolio by growing with our clients and we have had a number of examples of initially relatively modest premium relationships that have grown by multiples over time. For that reason, growth in active US client count can be a leading indicator of future growth. In 2015, despite the decision to non-renew a number of underperforming accounts, our net active-treaty customer-relationship counts have grown by 5%. Importantly, we continue to maintain high renewal retention levels.

We continue to stress the expansion of our highest margin lines of business and we're actively developing new products and services for our clients and prospects. Differentiation remains a key to our success and we're not resting on past accomplishments. Internationally, we saw a decrease in premiums from the impact of a strong US dollar in Maiden's IAS business, as well as a tapering off of runoff premiums from past discontinued programs. Maiden IAS develops branded consumer-insurance products for auto manufacturers and retailers, primarily in Europe.

Despite the revenue headwinds in 2015, our strategic partnership with Allianz Global Automotive developing payment-protection insurance and guaranteed-asset protection insurance opportunities, is gaining traction, along with other OEM opportunities and we expect the benefits of these efforts in 2016. In 2015 we added two new customer auto insurance OEM partnerships, Nissan and Volvo, with opportunities for growth. As you may recall, this highly differentiated business model is quite unique within the reinsurance sector, we're committed to its profitable, sustainable growth.

Finally, we have commented in the past several quarters of our efforts to offer capital solutions to help European insurers respond to the increased regulatory capital requirements that are resulting from the implementation of Solvency II. Our efforts were rewarded with a significant number of year-end opportunities which translated into four new-client relationships. We believe several of these new clients have the potential to grow with time. In addition, for a number of these relationships we have the potential to provide sub-debt through a majority-owned subsidiary, Insurance Regulatory Capital, or IRC.

For the AmTrust-reinsurance segment gross-written premiums increased by 17% to $1.9 billion, reflecting the continued impact of the Tower Group acquisition in the first three quarters of the year while experiencing organic growth throughout the year as well. Absent the fourth-quarter commutation, full-year 2015 gross premiums written for the AmTrust-reinsurance segment increased 21% to approximately $2 billion. Absent major acquisitions, we believe that AmTrust growth will return to more historical pre-Tower acquisition levels.

Turning now to the combined ratio, for the year ended December 31, 2015, the total combined ratio was 99.3% compared with 98% in 2014. The diversified-reinsurance segment produced a combined ratio of 103.3% in 2015 compared to 98.3% in the prior year. As I have mentioned, the biggest challenge faced in the diversified segment was from the US commercial auto line of business, which experienced prior-year adverse development throughout the year, but to a much lesser extent in the fourth quarter of 2015.

While adverse commercial auto losses have impacted many companies throughout the industry, we believe we have identified these trends relatively early. Importantly in identifying the development in many instances, it has enabled our underwriters to respond by either negotiating improved terms and conditions or exiting the adverse accounts. The balance of the portfolio performed within expectation, in fact, you may recall that several years ago we were impacted by poor non-cap property results. Today this segment is solidly profitable with new underwriting and pricing standards now in place.

We also experienced a higher-than-targeted result from our German personal auto portfolio in our IAS business; actions have been underway to strengthen performance and we're confident that underwriting profitability will be restored. The AmTrust-reinsurance segment produced a combined ratio of 95.3% in the year end December 31, 2015, compared to 95.4% in 2014.

We continue to be encouraged by our investment results and we have seen net income grow 12% in 2015 to $131 million. We expect continued growth in our invested assets, reflecting the expansion of our low volatility underwriting portfolio. Despite the current interest rate environment, we expect to increase investment income and enhance our return on equity while maintaining our disciplined investment philosophy.

I would like to now turn the call over to our Chief Financial Officer, Karen Schmitt, to review the fourth-quarter results in greater detail. Karen?

Thank you Art and good morning. As Noah said earlier, unless otherwise stated, all references to common-share data are on a diluted-share basis and comparative comments will refer to Maiden's results in the fourth quarter of 2015 relative to the corresponding period in 2014.

Maiden reported fourth-quarter 2015 net operating earnings of $26 million or $0.34 per share, compared with $35 million or $0.44 per share. Net income attributable to common shareholders was $25 million or $0.32 per share, compared with $28 million or $0.36 per share. Gross premiums written decreased 13% to $526 million from $602 million. Gross premiums written in the diversified segment totaled $146 million, a decrease of 14%.

Within the diversified-reinsurance segment premiums continue to be negatively impacted by the loss of a large US client that was acquired in early 2015. In the AmTrust-reinsurance segment, gross premiums written fell by12% to $380 million, compared to the fourth quarter of 2014 reflecting AmTrust's agreement with Maiden to commute liabilities relating to certain classes and lines of business. This resulted in a reduction in premiums ceded to Maiden in the fourth quarter of 2015.

Absent the commutation, premiums ceded from AmTrust in the quarter ended December 31 would have been approximately $446 million for a growth rate of 3%. This growth rate from the AmTrust is slower than in past quarters as the full effect of the Tower acquisition is now included in the prior-year comparison. The commuted reserve value of $107 million represents full and final settlement of all liabilities related to this business. There was no impact in underwriting income from the transaction. Written and earned premiums in the fourth quarter were lower by $65 million and $24 million respectively as a result of the commutation.

Looking now at the combined ratio in the fourth quarter, we reported a 99.9% combined ratio compared with 98.6%. The diversified-reinsurance segment combined ratio was 103.9% in the fourth quarter, up from 99.2%. The increase in the diversified-reinsurance combined ratio is due to a higher booking rate in our US underwriting portfolio, a smaller amount of adverse development in US commercial auto then in prior quarters, and an elevated loss ratio in the IIS auto portfolio, specifically from personal auto in Germany.

The AmTrust-reinsurance segment reported combined ratio of 95.8% in the fourth quarter compared to 94.9%, due to business mix as well as a higher booking rate for select portions of this segment. In addition, we had some non-operating prior-period adverse loss reserve development which mostly related to the NGHC run-off business and totaled $4.5 million for the fourth quarter of 2015. Absent this non-operating item, Maiden's combined ratio would have been 99.1% in the fourth quarter.

The annualized operating ROE for Q4 2015 was 11.8%. Net premiums earned a $584 million, decreased 4%. In the diversified-reinsurance segment, net premiums earned decreased 20% to $174 million. The AmTrust-reinsurance segment net earned premiums were up 5% to $410 million. Net earned premium comparisons in 2015 are impacted by our Corporate retrocessional program which was first purchased in 2015.

The loss ratio for the quarter was 67.8%, higher than the 64.8% reported in the fourth quarter last year. The commission and other acquisition expense was 29.4%, lower than 31.0% last year. The lower commission ratio is due to a smaller percentage of quarter-share business in Q4 2015 in the diversified segment, versus the same quarter last year. In addition, the commission ratio for AmTrust is 0.4% higher due to less premium being ceded via the hospital liability contract, which has lower acquisition costs.

The G&A expense ratio was 2.7%, compared to 2.8% for the quarter. In the fourth quarter net investment income was $35 million, an increase of 10%. The average yield on the fixed-income portfolio excluding cash is 3.46%, a small increase from 3.44% at the end of the third quarter. The new money yield on fixed maturities in the fourth quarter was 3.35% with an average duration of 5.95 years. Including cash, the average duration is 4.68 years versus an average duration of liabilities of 4.35 years.

Investable assets grew to $4.63 billion, compared to $4.5 billion at the end of September. Operating cash flow was $109 million during the quarter and $634 million year to date. Cash and cash equivalents were $333 million as of December 31, 2015, compared to $433 million at the end of the prior quarter. During the fourth quarter we actively invested $359 million in high-grade fixed-income securities.

Turning now to capital management, we remain comfortable with our current financial position and have a series of opportunities in the next 12 to 18 months to potentially lower our cost of capital and optimize our capital position. As a reminder, in November we issued $165 million of Series C Perpetual Preferred shares, with a coupon of 7 1/8. We plan to use this capital to fund the continued growth of the business.

In addition, we have the ability to refinance $107.5 million of 8 1/4 senior notes that are callable in June of 2016, and the mandatory conversion of our $165 million 7 1/4 convertible preferred shares will occur in September of 2016, increasing our capacity to issue debt or hybrid securities. The combination of these events will provide us with significant capital flexibility, and the potential to further reduce our cost of capital and improve our returns.

I'll now turn the call over to Art for some additional comments.

Thank you, Karen. As we've said in past quarters, while competition in our market segment is not as intense as it is it is more severity-oriented segments, we are experiencing increased levels of competition, even on our lower-volatility sector. We expect this competition to continue to intensify, given the continued growth of industry capital and for this reason we're keenly focused on enhancing our differentiation by delivering unique solutions to our target market, while maintaining underwriting discipline.

Despite the challenges of an increasingly competitive reinsurance market and volatile interest-rate environment, looking into 2016 we see a number of reasons for our optimism. In the US, we're working diligently to improve our underwriting margins and to find growth prospects in our higher-margin businesses. In our European international insurance-service business, our PPI partnership with Allianz is beginning to generate opportunities which we expect to pick up as 2016 progresses.

And Maiden's Solvency II Capital Solutions business, which offers both reinsurance and subordinated debt to small and midsize insurers, had a successful January renewal period which we expect to build upon during the year. In fact, we expect to reach to extend beyond Europe into Latin America and other Solvency II-implementing geographic areas. We also see capital solutions opportunities in the US. While we expect the AmTrust growth to moderate, we're very confident in their ability to remain disciplined and focus on the best growth opportunities.

As Karen mentioned, we have excellent optionality for capital management in 2016 and we will optimize our balance sheet depending on our potential growth opportunities and capital needs. Importantly, the relatively -- the relative stability of our underwriting allows us to offer shareholders a quarterly dividend of $0.14 per common share which, based on the current share price, has an annualized yield of over 4%.

While there are headwinds present in the market it is a testament to our low-volatility model that operating returns remained solid at 12% for the year. We are committed to enhancing underwriting performance, profitably expanding our underwriting portfolio and strengthening operating returns.

This concludes our prepared remarks, operator could you please open the lines for Q&A?

(Operator Instructions)

Randy Binner, FBR Capital Markets.

I just wanted to ask a question about what I would call the action in your loss ratio and the diversified reinsurance segment. I don't believe that we get a specific breakout of what was prior developments, it sounds like there was some in commercial auto and maybe a little bit in the German book.

But the real question is, what is the action in your loss pick in the fourth quarter versus the first quarter? Meaning, how much has that loss picking increased and is it reasonable to think it would remain at that level as we look to 2016?

Randy, when we look at, we're really looking at underwriting year as opposed to exiting year, but when we look at prior year development for the quarter in diversified it added, we added $11.5 million or 2 points to the diversified loss ratio. I'm sorry to the overall loss ratio.

In diversified it was $7 million which was 4 points. And then our NGHC added another $4.5 million, so we have $11.5 million total for the quarter of prior year development.

So it was 4% in the fourth quarter for -- I'm really focused on the DE RE -- so [69]. Then that would mean, so is your action in your loss pick really that much higher then, or was mostly the PYD that elevated the combined ratio for the quarter?

If you look at diversified without prior year development, it would have been 99.9%, which is clearly higher than our priced an our expected loss ratios. So the difference between that and where we were pricing the business would be the higher loss pick.

That's about 3 percentage points higher than what you target, because of I think you've talked about targeting more like 96%, is that right?

I think our target has been closer to 97% in recent years, so yes it is a couple of points.

Randy, it is a function too of business mix, obviously if we're writing more casualty business versus property. But I think as we look at the effects on our own portfolio from commercial auto in 2015 and we look at the primary pricing environment as well, we believe that there is a growing level of uncertainty and volatility. So that really is what is driving our higher booking rate, and I think that is prudent given all the uncertainty.

That's helpful, thanks. On the AFSI commutation, I think the communication that you all gave would imply that annualized, this is about $100 million to $150 million book of business? Or rough numbers like 5% to 7% of that overall relationship, is that an accurate way of characterizing the commutation with AmTrust?

On a run rate it is about 5%, it was just a little bit over $100 million on an annual basis. During the quarter we returned the unearned premium which actually, so the written premium change during the quarter was about $65 million, the earned premium change for the quarter was $24 million.

So the $100 million is your run rate estimate of net earned premium?

Yes. Over the course of the year.

I will just do one more and drop back in. Where is that runoff, can you characterize where you are in that runoff process? In general that would be a shorter tail book of business, obviously these exposures have a longer tail, any color you can give there would be helpful?

It is a relatively short tail book of business. They have had a few elements of the portfolio that a little bit longer, but remember it was $1 billion of premium, it has been running off now for a couple of years. We expect that we will get to the end of it within the next 12 months, I would expect. And it has been running a little bit adverse to where we had expected it to run, but we have been in taking a look at it, auditing it and we will continue to manage that runoff.

So you are saying 12 months from now that the runoff, I guess relative to maybe where it started can you, what inning we are in or some kind of characterization of how far through you are in that process?

Our general views is that we have a very modest level of development left. I think, don't hold us to an exact 12 months, I wouldn't see it extending much beyond the next 12 months in terms of the final runoff on it.

Ken Billingsley, Compass Point.

I would like to follow up on Randy regarding the commutation and I may have missed it if you did specify this, what lines and what is it that you were writing before that you no longer wish to write?

That is a good way to put it. I think first of all, as you know there are several segments that we have not agreed to take going forward and those have been excluded from the contract. We go through, as you know, a fairly ongoing process of audits where we will evaluate the business and understand what is going on from an underwriting perspective.

In the normal course of the business and some of it is relating to acquisitions, there have been some lines of business that have been added that are incidental to that business. And what we really focused on in 2015 was identifying all of those and then sitting down with AmTrust and talking about potentially resolving these areas that are out of our underwriting focus. We're not saying that they are necessarily unprofitable but one of the focuses we've always had across our business is underwriting things that we understand.

I think that AmTrust has a good team and I think we certainly believe these will be profitable businesses. From our perspective we felt the best way to settle this and I think, obviously AmTrust agreed, was to commute those balances in the fourth quarter and that is what we did. The lines of business are chiefly more specialty lines in Europe, some of the professional liability lines, some ANS and I think surety is another segment that was part of that as well.

We see this as not a recurring item, we will always look at the business and see whether there are areas that no longer conform to our focus. And to provide them the most efficient reinsurance solution it's important that we maintain the same level of consistency and stability in the portfolio, and as we have always found them to be, they were very amendable to work with us and come up with a solution that worked for both of us.

I know you're saying some of these lines are ones that were not in your wheelhouse, but especially in Europe, were any of these lines that you guys potentially might actually bump up against each other from a competitive standpoint?

No, we would not.

On the commercial auto loss, this was three quarters I know you've talking about repricing and re-underwriting that business, would it be safe to assume that we might have another quarter of this before it starts to improve? I would imagine you're trying to clean house at the end of the year, but these things tend to drag on annually. Is there a chance that we could see a little bit more deficiency going into the early part of 2016, or what makes you think you have captured it all?

I guess there is always a chance. The one thing I will tell you is that our worst reserve review was the first quarter which was booked in second quarter. Second quarter reserve review booked in third quarter was probably half the level of development, and then this latest reserve review was half that level development. So it is getting progressively smaller which we are certainly happy to see.

I think the higher initial booking rates will help a little bit, but we can't rule out that something else won't come up. We're going to continue to look at it every quarter and the re-underwriting certainly is expected to help, but there really can't be any guarantees.

Remember Ken, the way we reacted when we saw the development initially was we extended a much more aggressive and active case reserve evaluation where we did onsite visits with every client that had exposure to commercial auto. We looked at the individual reserves, not just the ones that had been reported but those but that might be under our retention because most of this is excess. That caused us to increase our expected case reserve and from there we applied incurred but not reported reserves.

We believe we responded effectively to it and I believe that based on what we're seeing in terms of new claims that are coming in relative to development, it's certainly moving down. So we are certainly confident that we reacted effectively and have done what we needed to do. I think if anything follows next year it could be more latency that we haven't identified before, but we do believe we have addressed this effectively.

I'd like to move to the expense ratio if I could, I believe someone said there's a business mix shift, is that the major driver is what is pushing acquisition cost lower?

Yes, in diversified in particular there is a -- because of the loss of the large account which was a large quota share, that actually has a favorable impact on the expense ratio for that piece.

Just two other quick questions, one, looking on the balance sheet additional paid in capital is lower from the third quarter to the fourth quarter, anything driving that regarding outstanding capital structure that may be pushing that down?

I don't have the third quarter piece, I'm going to have to get back to you on that one.

I will circle up with you offline. The last question, and I don't know if there's a shift in investment philosophy, but I wanted to clarify. Are you going to be doing anything different with your investment portfolio in 2016 going forward?

No, I think quite honestly, I think that 2015 pretty much validates our strategy of maintaining a low risk, high quality bond portfolio. I know that many in the industry have taken more alternate investment strategies, but I think if -- we've always said that part of our low volatility model is to ensure that we have effectively reduced risk both in the underwriting and the investment side. And to deviate from that strategy would require incremental capital, we just don't think this support the returns and the volatility support, any incremental additional capital for more volatile investments.

Thank you for taking my questions and I would imagine most companies would love to have 12% tangible equity while studying themselves up for next year, so look forward to 2016.

Thank you Ken, obviously we certainly liked to have seen a better underwriting result and we are committed to improve it. But I guess we would have certainly liked to see a stronger return, but we are committed to strengthening.

Matt Carletti, JMP Securities.

I see Randy and Ken covered most my questions, I had one and it related to, Art something you mentioned in the opening comments, you mentioned particularly the Solvency II capital solutions for new clients. Would those all be at January 1, or were any of those in Q4 and hard to see the numbers because of the lost client with the headwind?

Actually they are all January 1. Just to give you little more background on what we saw, we saw tremendous volume of quoting opportunities more than we anticipated, but we were very selective. I think some of the ones that we passed on we may look again at next year.

But yes, we have four relationships, among those relationships there are a couple that have the ability to upsize within the terms of the contract. In addition to that, a couple of them also have expressed an interest in also pursuing sub debt. We found a very receptive market and it continues. I think we have a fairly good pipeline of first quarter, second quarter opportunities that we are evaluating.

Do these have a typical size to them, are they fairly chunky or are they maybe across the board in terms of size, these four new clients?

Some are -- we estimate probably about $20 million from these four clients as the initial size. There are some that are higher and lower, but I think it's a pretty balanced portfolio.

As I mentioned, some of them have within the terms of the contract the ability to upsize, because these are for capital solutions. So the optionality to grow a quota share, and for the most part the majority of them are quota share arrangements.

Is this sort of product typically a January 1 product given -- I imagine these companies are trying to set their capital up for the year? Or do you expect to see ongoing, throughout the year opportunities, or is it more of we have to wait for the next cycle in the next January 1?

They are not in January 1 oriented, in fact at least one of these programs was not in existence before. It was really a function of us interacting with the client and obviously the broker who sponsored the client, and really understanding what their capital needs were and then structuring something that would make sense for them. From our perspective that was definitely important.

I think one of the things that happens is that the solvency capital ratio there is a requirement for enhanced transparency, so these companies will publish their solvency capital ratio. As that process takes place, one of the things that we have seen in a number of the opportunities, both the ones we wrote and haven't written is, as that transparency comes into play, companies are as concerned of the relative position they are versus their competitors, versus where they were before. None of these companies were in a absolute solvency meltdown.

They met Solvency II required capital standards, but they were for the most part prudently managed companies that wanted to make sure that they had the same level of solvency margin that they had pre-Solvency II. I think that's kind of the nature of a lot of the opportunities we're seeing coming forward. So we do think there is an opportunity really over the 12 months, a big part of it is getting in front of those prospective customers and really talking about capital rather than just pure reinsurance structure.

Makes sense. Great, well thank you for the answers, and best of luck in 2016.

Thank you very much, I appreciate it.

I'm not showing any further questions at this time, I'd like to turn the call back over to Noah.

Thanks everyone for joining us today and we look forward to speaking with you in the future. Have a great day.

Ladies and gentlemen this does conclude today's presentation. You may now disconnect and have a wonderful day.